Ladies and gentlemen, welcome to the presentation of the Hexagon Interim Report Q3 2011. Today, I'm pleased to present Mr. Ola Rollén, President and CEO. For the first part of this call, all participants will be in listen-only mode, and afterwards, there will be a question- and- answer session. Mr. Rollén, please begin.
Thank you. Welcome to this Interim Report for the Third Quarter of 2011. If you flip to slide four, we have the overview of the third quarter. We've reported solid organic growth of 13% in the business. Growth is primarily driven by the recovery in the Western markets, as well as strong demand from customers, primarily in the engineering or manufacturing sectors, automotive, aerospace, and the energy-related segments. If we exclude the weak activity in the high-speed rail in China, Geosystems grew globally, with organic growth of 6%. The negative FX impact in the quarter was -3%. It had almost no impact on margins. We did, though, have an FX impact on margins stemming from the Smithson. In spite of that, we report strong growth in EBIT margins in measurement technology, 54% gross margin and 20% EBIT margin. If we move to slide five, we just want to emphasize that the third quarter is still the weakest quarter in the Hexagon seasonality, even though it's less accentuated with the Intergraph in the group. Moving on to slide six, key figures. Net sales amounted to €521 million, which is 13% above last year's third quarter, if we exclude acquisitions and currency fluctuations. Operating earnings amounted to €99 million, up 71% over the previous year, and that corresponds to an EBIT margin of 19%. Earnings before taxes amounted to €84 million, and earnings after taxes, €67.4 million, which corresponds to an earnings per share of €19. The nine months, slide seven, operating net sales, i.e., excluding the revenue haircut of €8.5 million, amount to €1.586 billion, which is 15% above the previous period last year in organic growth. Earnings before taxes, excluding non-recurring items, amount to €274 million, which is 74% above the same period last year, and that corresponds to an earnings per share of €60, including non-recurring items, and €61, excluding non-recurring items. Slide eight, cash flow. We had a strong cash flow for the quarter, €122 million before taxes and interest. We had a positive change in working capital of €23.3 million, while cash flow from operations amounted to €127 million, almost double what we generated in the third quarter of 2010. Ordinary investment activities were some €6 million above the first half this year, and that has to do with significant investments in North America, Europe, and India. Net operating cash flow amounted to €91 million. Slide nine, currency effects as compared to the euro. We have a negative exposure to the Swiss franc, which means that we had a negative profit impact in the third quarter stemming from the appreciation of the Swiss franc, amounting to €8 million in the quarter. The total negative impact for the nine-month period is €15.5 million. The U.S. dollar has depreciated against the euro over this nine-month period. It's had a negative impact on top-line growth, but not really a noticeable impact on the margins. Market development, slide 11. North America now represents 28% of our business. South America is up from 3% in the previous quarter. EU, 34%. Eastern Europe, Middle East, Russia, and Africa, 7%. The rest of Asia has grown from 11%- 13% of sales, and China has shrunk from 21% pre-Intergraph to 14% in the third quarter. Slide 12 is a bit busy, but let me take you through it. The green arrow represents market and segment growth above 8%. The yellow arrow represents growth between 0% and 8%, and a red arrow represents negative growth. What we've seen in the third quarter, as compared to the first six months of this year is that we have negative growth in surveying, where we basically book the high-speed rail business in China. We have negative growth, and we've seen a slowdown in the construction activity in China. Surveying in general is still not very strong, but we have positive growth in the mature markets, while South America, Middle East, and Africa and APAC is growing above long-term trend lines. Power and energy is reporting very strong growth in all regions, except for North America. Within North America, Canada is actually performing quite well, while the United States is a bit sluggish. We move on to aerospace and defense. We see good activity levels from virtually all regions: Western Europe, North America, South America, and China. Public safety and security had a weak quarter in terms of invoicing, but a very strong quarter in terms of order intake. We had negative growth in Western Europe, weak growth in North America, but strong growth in South America. Construction, as I've mentioned, is still sluggish in the North American markets and the Western European markets. South America, significant growth. We see the slowdown and the cooling off in China. Asia-Pacific, single-digit growth. Automotive is another segment that is growing substantially, and virtually all auto manufacturers are investing in new plant and equipment and new models to be launched in the coming years. Manufacturing activity is good in all areas, but China, where we do see a slowdown for the manufacturing sector. I f we summarize, Western Europe, strong growth; Middle East, Africa, strong growth; North America, strong growth; and really, the only two regions where we have single-digit growth is China and Asia-Pacific in the third quarter. Moving on to slide 13, basically repeating what I've just taken you through. In EMEA, growth comes primarily from Northwestern Europe. We do see improved demands sequentially for systems use in industrial segments such as automotive and aerospace. Still, slow recovery for infrastructure and construction. Weak sales, but strong order intake in public safety. High demand for CAD software used in power and process industries. Southern Europe remains weak. Eastern Europe and Middle East continue to grow, and we report 13% organic growth in the region. Slide 14, Americas. NAFTA, automotive, aerospace, general engineering, and infrastructure grew at double-digit rates. Some of the segments had significant growth rates. Strong demand for CAD software in relation to power projects in Canada, weaker in the United States. Flat sales in public safety, but backlog at record levels. Residential housing remains weak. In South America, all segments are growing at double-digit rates. Our growth rate, organic growth in this region, amounted to 27% in the quarter. Slide 15. Asia was a bit of a disappointment, 1% organic growth. If you exclude high-speed rail, the region grew at 10%, and China grew at 20%. Growth in China is still driven by metrology and other surveying applications, but high-speed rail. Automotive, aerospace, power and process applications grew significantly in the quarter. We do see the construction and parts of the manufacturing industry slowing down due to cooling off measures by the Chinese government. Australia, Japan, and Korea continue to grow, but we recorded negative growth in Southeast Asia and Central Asia. Slide 16 displays this graphically, and we can see that we're back to pre-crisis growth rates in organic growth. Segment information, slide 18. Net sales for measurement technologies amounted to €508 million, and that corresponds to a 13% organic growth in the quarter. Operating margins came in at a record 20% for a third quarter. The third quarter is still our weakest quarter, and that is 67% above the profit level of Q3 2010. Slide 19 displays growth rates between the two major segments, Geosystems and Metrology, and we can see the very impressive growth rates from Metrology and the low growth rates impacted by high-speed rail for Geosystems in Q2 and Q3. Moving on to slide 20, our gross margin came in at 55% for the nine-month period, compared to 52% for the corresponding period last year. In the quarter, it was 54%. EBIT margins, slide 21, came in at 20%. We're at our target level for this year. Slide 22 and onwards, I'll introduce you to some acquisitions, orders, and product releases. We've completed four acquisitions during the nine-month period. We acquired Denali Solutions, a U.S.-based records management software company for public safety and security applications. Seven Ocean is a Chinese vision technology company that will be integrated into our metrology portfolio. Slide 24, Augusta Systems is a software company that enables detailed real-time information from sensors such as video cameras, totem stations, GPS receivers, and so on. It has the ability to link that information into Intergraph's GIS systems. It's sort of the grid between Geosystems and technology. Sysgraph is a software and technology provider in South America that is servicing primarily Intergraph's in the region. Slide 25. This is the first installation where we've invoiced a customer using Hexagon and Intergraph technology in combination. It's called La grande frana di Ancona, and it's in the city of Ancona in Italy, where we've installed a monitoring system monitoring the slopes around the city and basically detecting any landslide that is occurring and giving early warning to citizens of the city of Ancona. Last week, we introduced this system to some 80 delegates from across the world that are interested in landslide applications. Slide 26. Significant customer wins in the quarter for our CAD software within Intergraph PP&M. We received orders from INPEX based in Australia, Weiss in China, Engevix i n Brazil, Tecnomare in Italy, Siemens Energy from Germany, Samsung Heavy Industries Korea, and Toyota, an EPC based in Thailand. Slide 27. Ecovix is an interesting order that we received via Sysgraph in the quarter. It's a supplier to Petrobras, and they will standardize on Hexagon's 2D and 3D software for the construction of so-called FPSO hulls to support one of the largest oil discoveries off the Brazilian coast. Slide 28. We received a significant customer order from the Danish Ambulance Authorities in Denmark. All the regions in Denmark will be coordinated and join forces to replace old legacy systems with a new state-of-the-art emergency dispatch system from Hexagon. Slide 29. We received a similar order for a 911 expansion system in the state of Rio Grande do Norte in Brazil. What's interesting with this order is that we now had half of all the hull switches for the 2014 FIFA World Cup customers, and we're working hard on getting the remaining half. Slide 30. We received a customer order from Westar Energy in Kansas, United States. It's the largest electric energy provider, and they will use our system for outage locations and directing mobile workforces. Slide 31. The Colombian Army bought systems for us for mission planning in the Colombian Amazon. Slide 32. The city of Richmond in Virginia, United States, bought software from Augusta Systems to be able to offer coordinated information sharing from critical sensors around the city. Slide 33. The state of Steirmark in Austria underlines its pioneering role in disaster control, and we are to deliver a command information system for all public safety and security agencies in the federal state of Steirmark. Slide 34. The Department of Microbiology in Russia acquired Hexagon's ERDAS APOLLO software, and this is actually the first time we've sold a Hexagon product through an Intergraph distribution channel. Slide 35. We received several orders from Africa regarding photogrammetric solutions. The Ministry of Lands Housing in Malawi, in Africa, and the National Mapping Agency in Kenya. Slide 36. Those of you that have followed the new launch of the Apple iPhone 4s have noticed that it has an extra lens, and that lens is produced by a company called Lens Technology, and we do the measurement inspection using the Seven Ocean technology. Slide 37. This is an interesting application. It's the particle accelerator in CERN in Switzerland, where they demonstrated tests to prove Einstein wrong. They are using a Leica absolute tracker to align the particle accelerator. Slide 38. This is also an interesting breakthrough order where we do assembly guidance systems for assembling large parts of the fuselage in Airbus. Slide 39. We received several large orders for our laser scanning equipment in the quarter from CSI bureaus, but also from BMW's Accident Research Center and United States Air Force. Slide 40. We have a significant product release in the quarter. It's Smart 3D 2011 SV1, where we have more than 1,200 enhancements compared to the previous version. Slide 41. We showed this technology at the Orlando customer meeting. It's basically our dehazing capability that we've now built into our product, Video Analyst. Slide 42. We've released a new IMU GPS combination, which only weighs 100 grams and is targeting the unmanned aerial vehicle and land-based vehicle market. Slide 43. You might not know, but every 13 years, there are solar storms having an impact on radio traffic on Earth, and it will also have a negative impact on GPS receivers. What you do then is you launch a product that can fix the signals so that you don't have a significant impact from the solar storms. The next solar storm is expected by 2013. If you're worried about your GPS signals, this is time to buy an upgrade. Slide 44. We've released a new set of softwares for our laser scanning product, like Cyclone 7.2 and CloudWorx 4.2. Going forward, slide 46. We basically repeat our expected market conditions for 2011. We expect all regions to continue to grow and that we will see increased demand in 2011. If we summarize on slide 47, this was yet another strong quarter for Hexagon solid growth. We delivered the first joint project between Hexagon and Intergraph. We have a 20% EBIT margin in the core business in spite of the seasonality and the currency headwinds. I will finish this by making an advertisement for Hexagon 2012, our customer and our capital markets day, to be held in Las Vegas in the United States on the 4th through the 7th of June 2012. Thank you very much for listening, and I'm now open to trying to answer any questions there might be. Thank you.
Ladies and gentlemen, I remind you that if you have a question, you need to press zero one on your telephone keypad. The first question comes from Mr. Lars Brorson from DNB North. Please go ahead.
Yes, thank you very much. Good afternoon. It's Lars Brorson from DNB North. I had three questions, if I could. Firstly, on your slide 12, the overview of customer segment, that's a very useful overview. Thanks for providing that. If we look at your metrology segment on this slide, what's your current view on the sequential outlook into Q4, and to what extent are you seeing uncertainty affect customer activity in terms of, shall we say, greater caution or extended lead times? Maybe if you care to comment on the current size of the order book and book-to-bill ratio in the metrology segments, that would be very useful. Thanks.
Yeah. Shall I start with that? You had three questions, or?
No, that was the first, actually.
Okay, I'll answer that. The sequential outlook is we expect continuous growth for metrology in the fourth quarter. Automotive is strong, and we do believe that this activity can't continue going into 2012. It's a bit difficult to give any predictions now, but we have a growing backlog for aerospace applications. 2012 seems to be a very big and busy aerospace year indeed for metrology, and the backlog is at an all-time high.
That's useful, Ola. Thank you. Maybe I could ask specifically to the negative growth you've seen in Southeast Asia. Is that due to high comparables in 2010, or are you seeing any concerns for underlying growth here? If you, within that particularly, would care to comment on India, that would be appreciated.
India had a somewhat more sluggish growth than the rest of Asia in the quarter. We do think it's temporary. We've seen cooling- off measures from the Indian government as well. They're a bit concerned about their inflation rates and consumer spending, as you might know. India didn't have a particularly strong quarter when it comes to, for example, automotive. Going into the fourth quarter, we expect that to pick up. India is still a fairly small market, though, in Asia for us.
I appreciate that, Ola. Thank you. Secondly, if I could just talk, if we would just talk briefly about the revenue synergies and joint projects that you talk about in your report and also your comments on the call about the Ancona project. Could you elaborate on whether your solution for this particular project was based on an integrated solution or whether indeed you could have delivered on this on the separate legacy solutions? Maybe more generally, if you could provide some additional color around what these joint projects are and really what the commercial materiality of them is at this point.
We couldn't have delivered this without the joint effort. We've done R&D. It's really about the interface between the sensor and the ability to send that information to a georeferenced map. You couldn't have done that without having both pieces. We believe that this area where you talk about monitoring, i.e., natural disasters, and you need early warning systems to predict that, is a very interesting theme. We see great opportunities both in mature countries and economies such as Japan and Italy, where you have fault lines and so on, but also emerging markets like China and countries throughout Southeast Asia, where you do have natural disasters and you want early warning.
That's useful. A third question, maybe just related to that, to the joint projects. Can you give a little bit of flavor of how your R&D costs are currently developing, i.e., where they're running as the percentage of sales and where you see the longer-term normalized level for R&D costs leveling out as you look to drive greater integration between the legacy platforms? I'm talking about R&D costs, both expensed and capitalized. That would be useful.
I don't think we see a significant increase in R&D expenses if we call it like that, because then you can just record whether it's cost or expenses. There is always, obviously, there will always be a long-term trend that it will increase with salary increases and expansion into new areas, but nothing significant. I think our general guidance is that depreciation and amortization should more or less be in line with capitalization investments. That still holds true.
In terms of the total level of R&D cost, do you see them move up sort of a step change from here at about 10% or 11% of sales?
We should be around between 10% and 13%. That's where we've been for the past 12 months pro forma. That can vary from quarter to- quarter, but I don't see a step change from that level. We actually have initiatives where you could have the opposite, where we're transferring R&D work from high-cost regions to low-cost regions.
That's useful. Thank you.
The next question comes from [Mr. John Hilden] from Handelsbanken. Please go ahead, sir.
Thank you very much. I have three questions, if I may. The first one is on growth in Americas. It really surprised me that it came in so strong. It accelerated quite a bit versus Q2. If you could say something, if it's something out of the ordinary or if it's just normal business, just give us some more color on that, please. Secondly, on the Chinese part, I wonder what organic growth in China is including rail and in what quarter your comps will be without the Chinese rail anymore. Thirdly, on working capital, you had a pretty good working capital release. It looks at the glance that your inventories are up, and it comes more from the other side on payables or something like that. If you just could give us some more details on how you cope with this working capital release, please.
If we start with growth in Americas, it's two things that are growing significantly in Americas right now. You could say if we look at the Geosystems business, it's been still not very impressive growth from construction and the infrastructural activity. On top of that, things like laser scanning and new technologies, mobile mapping, which is, for example, when you look into Google Maps, that's the technology that we call mobile mapping. That's grown significantly in North America. On top of that, we've had a recovery in the defense-related market when it comes to unmanned aerial vehicles from the U.S. Air Force. Metrology has significant growth primarily from aerospace, but also from other manufacturing companies like Caterpillar and so forth and automotive. That's North America. South America, obviously, which is a part of America, is growing at double-digit rates for all segments. South America is probably our strongest region in the quarter. If you look at China, it's 6% growth in the quarter, including high-speed rail.
When it's the high-speed rail, completely out of the books in terms of tough comparables.
In terms of tough comparables, I would say you're going to see an evening off already in the fourth quarter, but it's really as of the first quarter and onwards. It's not dead, but it's not on the levels that we saw in Q2 and Q3 of 2010.
How big is this segment, or how big was it at the peak last year?
It was growing to become roughly €50 million.
Okay. The last one, please, on working capital. Was it a table for you? What item did you have a good success in making the release fairly good?
It's nothing dramatic. It's just that Intergraph's business model, you could say, is catching up from the acquisition. It was primarily Intergraph contributing with the working capital release. Since we have significant prepayments in Intergraph, you had payables that are growing, and you're at the same time that you're releasing inventory.
Okay. That's very helpful. Thank you.
Thank you.
The next question comes from Mr. Björn Enarson from Danske Bank. Please go ahead, sir.
Yes. Hello. One question remains for me. It's on outlook. In your regional comments, you provide us with some good outlook comments. Could you just say whether what you're trying to indicate is what kind of demand situation we are looking for in Q4, or is that a summary of the full year? I mean, you have had quite a strong nine-month performance, so I'm just trying to get your feeling about Q4, really. Thanks.
That's a difficult question since we don't give forecasts, but we expect growth in the fourth quarter, obviously.
On the market, I mean, you're obviously giving some market outlook, not the company sales growth forecast. Do you expect the Q4 market to continue to grow at a healthy rate, or are you primarily talking about the period up to this date and then the implied growth rate in Q4 is yet to be seen, or how is it related to them?
What do you want me to answer without giving a forecast? You could say the comps are getting tougher and tougher to beat, obviously. We've always talked about an 8% long-term growth in this market. I guess we will see, but we are expecting growth in the fourth quarter.
Okay. Fair enough. Thanks.
The next question comes from Mr. Ben Maslen from Bank of America. Please go ahead, sir.
Good afternoon. It's Ben Maslen from Bank of America. Three questions, please. Firstly, Ola, you had a better cash flow in Q3. Can you talk a little bit about what your expectations are in Q4? I think it's normally seasonally stronger. Where do you think your level of net debt or net debt to EBITDA will be at the end of the year? That's the first question. Within technology, which you report as kind of structure or an acquisition, can you talk a little bit about the organic growth within that division, split between PP&M and SG&I for the quarter? Thank you.
Thank you. Cash flow, we are seeing nowadays that we have weak cash flows in Q1 and Q2, and then we have strong cash flows in Q3 and Q4. I don't see, it's difficult to predict, but I don't see why that shouldn't happen this year again. Our forecast is a fairly strong cash flow in the fourth quarter. When it comes to organic growth rates in technology, it consists of three pieces. We had negative growth in SG&I in the quarter. Surprisingly, not in order intake where we had strong growth in the backlog, but we had negative sales growth from SG&I in the quarter. We had strong double-digit growth in the PP&M business, i.e., the power, process, and marine business in Intergraph. We had strong double-digit growth in NovAtel, which is our GPS specialist.
Okay, if I—sorry.
Sorry. I missed one question, and that was net debt to EBITDA.
That's right. Thank you.
I mean, we're currently trading between 3.5x and 3x, and that's where we're going to end the year. Our forecast is still that we're going to be at or below 2.5x net debt to EBITDA by December 2012.
Okay, that's fair.
You can draw a line.
Okay. If I can, just to follow up on the SG&I orders being much better than revenues. Without much experience in this business, how long does it take for that better order intake to feed into your revenues and for SG&I to grow again?
It varies. For example, I showed you the order from Denmark. That's a significant order. It all has to do with the percentage of completion where we need to install certain equipment before we reach certain toll gates where we can invoice. It could be erratic, but it's a much better situation to have a significant backlog going into more uncertain times than not. We're actually fairly happy with the situation, if I can put it like that.
Okay. Got it. Thanks a lot.
Thanks.
The next question comes from [Mr. Dani el Djurberg] from SEB. Please go ahead, sir.
Yes. Thank you. A question on two subjects: capacity, utilization, and production rate. Could you say anything about that when it comes to the reported numbers for Q3 today and the plan for Q4?
We are operating at, I mean, we have, first of all, capacity utilization is not very meaningful for us since we buy components and then assemble them. I mean, for software, you basically issue another piece of software, and capacity is not a meaningful ratio when you have that setup. If we talk about production rates, the fourth quarter is, regardless of if you're in a recession or in a peak economic situation, it's our strongest quarter. We are going to ship much more in the fourth quarter compared to the third quarter.
Would you view production rates in Q3 as normal compared to end of Q3?
Yes.
Okay. Thank you.
Thank you.
The next question comes from [Mr. John Joseph] from Handelsbanken . Please go ahead, sir.
Thank you. I have two follow-ups. The first one is on the automotive segment. You mentioned in the presentation that you had an extremely high activity level this year and that it might be tough to meet next year. Could you elaborate a bit more on that? If that is including all regions or some particular regions, please?
It's a somewhat difficult question to answer because it all has to do with the plans of the OEMs, obviously, and what they are planning to do for next year. The forecast for the automotive industry is that total output should grow from 72 million vehicles in 2010 to 105 million vehicles by 2018, which is a 45% increase. That increase is not going to happen in Western Europe or indeed in North America. It is expected that South America will grow by 70%, China by 70%, the rest of Asia and Eastern Europe by much more. I think it's the automotive manufacturers that are currently building plants in Eastern Europe, Central Asia, China, Southeast Asia, and South America that will benefit. Those are the ones we try to target.
If I rephrase it a bit, what type of visibility do you have in your customers' plans in building out new plants? Because if I understood it correctly, your main benefit comes in the early phase when there's a capacity build-up in the automotive industry, not really from the production level.
The production level has nothing to do with it, but the number of models or model variations times the number of new factories. That's what determines our growth, plus new technologies that we can launch to improve their productivity. Those three main criteria are really what you have to look for. When we look at visibility, we can see new car models and plans for new car models. There is definitely sort of a hump in the next three to four years with planned launch of new models. We do see an expansion geographically in new regions. We don't know what it means for, let's say, the next few quarters.
Okay. You mentioned previously that it didn't mean that you're meeting extremely tough comps, and it will be tough to grow the auto segment for you next year, irrespectively of how the online economy goes.
I believe that auto will not grow the way it's grown in 2011. What I don't know for metrology is what significance we should put on the shipment plans from the larger aerospace manufacturers replacing auto in 2012 from a volume point of view for metrology. It's still too early to determine what it will mean for us.
Okay. Sure. A much more direct question regarding the tax rate. I think it's been around 20% now, and I think you hope for a lower tax rate. Are you approaching any good solutions that could suggest that you will have a lower tax rate in Q4?
We're working on it. We'll see.
All right. Thank you very much.
Thank you.
We have a follow-up question from Mr. Ben Maslen from Bank of America. Please go ahead, sir.
Yeah. Hi. Sorry. A couple more questions, if that's okay. Just on the mix of the different businesses. I mean, metrology is growing, you know, by far the kind of quickest at the moment, I think. I just wonder whether that has any drag on your margin, whether it's, I think it was slightly lower margin you said before, whether if that slows down next year, it will actually help the margin a little bit. Then secondly, just can you talk a bit about the machine control business within Geosystems for construction equipment, mining, and ag, and so forth? Just a bit on how that is developing at the moment and how we should think about the growth. You know, if Caterpillar and Volvo expect 10%- 15% growth in equipment next year, you know, is that a good proxy for what machine control can do? Because I guess it's installed on their machines. Thank you.
Thanks. This requires diplomatic answers since probably several people at metrology are listening. I wouldn't say that it would be good if we saw slower growth rates from metrology next year from a group point of view when it comes to margins. What's happening in, if you look within the metrology business, we're moving from what we call stationary metrology to portable metrology. The margins are actually greater in the new technology compared to the old technology. Right. Over time, we do see a margin lift in metrology, and we have great expectations on them for margin lift. Your second question regarding machine control is not entirely true because we work in two segments. We work with the OEM and have factory- installed equipment, but we also work with the installed base of machines in the market that doesn't have machine control. Right. That's the vast majority of excavators and dozers today.
Okay. The growth you're seeing in that segment is fairly weak, caught up in your general comments on construction. Is that right?
No.
Okay.
It's more levels, laser levels, distance meters, and tools used on the construction worksite, hand tools to measure, that are suffering. Right. The machine control business is actually strong.
Okay. Thanks, Ola.
Thank you.